Comparing Cost-Mitigation Techniques

This article compares the efficacy of three common transaction-cost-mitigation techniques: limiting a strategy to cheap-to-trade securities, rebalancing a strategy less frequently, and “banding,” which imposes a higher hurdle for actively trading into a position than for maintaining an established position. All three strategies significantly reduce transaction costs, but the techniques that reduce turnover have a less negative impact on strategy gross performance than limiting trade to low-cost securities has. Banding is more effective than simply reducing rebalancing frequencies, because banding yields similar trading-cost reductions while maintaining a better exposure to the underlying signal used to select stocks.Disclaimer: The views expressed in this article are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of Richmond or the Federal Reserve System. We thank Barbara Petitt, CFA, Stephen Brown, and Milena Novy-Marx for discussions and comments. Robert Novy-Marx provides consulting services to Dimensional Fund Advisors, an investment firm headquartered in Austin, Texas, with strong ties to the academic community. The thoughts and opinions expressed in this article are those of the authors alone, and no other person or institution has any control over its content. Editor’s Note Submitted 28 June 2018Accepted 27 September 2018 by Stephen J. Brown